How Michigan blocked a $1 billion tax windfall for corporations

Michigan lawmakers were fired up following an unfavorable state Supreme Court decision in a lawsuit brought by IBM. With astounding speed and overwhelming bipartisan support the legislature swooped in and passed a law blocking an unexpected $1 billion in corporate tax refunds.

For all the talk of political gridlock, it is amazing how quickly a state legislature can act when $1 billion in unexpected corporate tax refunds are at stake. The lawmakers are in Michigan. And their pistons were fired up following an unfavorable state Supreme Court decision in a lawsuit brought by IBM.

The case involved the way multistate corporations calculated their state income tax liability from 2008 to 2010. The trouble for Michigan is that, during this time, they had two ways to apportion state income on the books: one, which they thought no longer applied, based on a three-factor formula—the shares of a firm’s property, payroll, and sales present in the state—and the other based only on sales in the state.

IBM lawyers argued they could choose the more beneficial formula. Michigan disagreed. IBM sued and won.

The case was decided in July. With astounding speed and overwhelming bipartisan support the legislature swooped in and fixed the problem in less than two months. And Governor Rick Snyder (R) signed the new law as soon as it landed on his desk.

So what was so compelling? The amount of money, of course. But there is more to the story than just the dough.

Under a system widely used by states for decades, a firm allocated its taxable corporate income using the three-factor formula. This model was set up in the 1960s by a group of states and became part of a multistate tax compact (MTC). One provision of the MTC allows taxpayers in member states with an alternative formula (like the single-sales factor formula) the election to apportion using the three-factor formula.

When Michigan set up the Michigan Business Tax (MBT) in 2008, it required companies to source their income based on their Michigan sales only. The so-called “single-sales factor,” is becoming quite common across the country and Michigan, like other states, saw it as an economic development tool. The idea: A firm is more likely to hire and invest in a state that does not factor employment or property value into its tax calculations.

Unfortunately, when Michigan adopted the MBT, it failed to repeal the MTC language permitting the three-factor option, believing the new law preempted the compact. (Even though the MBT’s predecessor, the Single Business Tax, used the same single-sales formula, it was considered a value-added tax rather than an income tax and so the MTC didn’t apply.)

But IBM argued that the MTC language gave firms the option of using the three-factor formula instead of the single-sales formula to apportion the new income tax, a step that would save it a boatload of money. (A similar case caused headaches in California). The MTC, they argued, was a binding contract with other states and the new state law could not automatically preempt it.

The state claimed the MTC is an advisory compact meant to encourage uniformity but not meant to hinder sovereignty and the intent of the legislature was to require single-sales factor apportionment despite the MTC.

Because Michigan replaced the MBT in 2011 with a corporate income tax using the single-sales factor only and explicitly barred firms from using the three-factor formula, the only years affected are 2008 to 2010.

Following the court’s ruling in favor of IBM in July, Michigan legislators were terrified of the prospect of hundreds of other corporate taxpayers recalculating their back tax bills using the more favorable formula for those three years. That could cost the state $1 billion—about 10 percent of its annual general fund revenue.

The fix was simple. The legislature codified its original intent by repealing the MTC retroactively to 2008 and wipes out all of the cases pending but not adjudicated. The opposition—3 of 37 state senators and 10 of the 100 state representatives—insisted it amounted to a tax increase.

But the state never intended to give firms a choice in apportionment methods when it adopted the MBT and few other lawmakers saw the legislative fix as a tax increase. It just closes a loophole, preventing what would be a huge tax windfall for a handful of multistate firms.

Oh, and don’t worry about IBM. Unless the court reverses itself, it will get its $4 million refund from its disputed 2008 tax return.

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